IDEAS home Printed from https://ideas.repec.org/p/ecm/latm04/249.html
   My bibliography  Save this paper

Exerting local tax effort or lobbying for central transfers?: Evidence from Argentina

Author

Listed:
  • Pablo Sanguinetti
  • Martin Besfamille

Abstract

In many countries fiscal decentralization characterizes the relationship among different levels of government. In those countries, local authorities have the prerogative to tax their constituencies. However, fiscal decentralization is seldom balanced in terms of tax and expenditure assignments. In order to equalize tax capacities, to internalize spillovers or to achieve national policy objectives, central governments often provide transfers to lower levels of government. These transfers may affect the incentives to manage or to improve fiscal performance. Specifically, according to Litvack, Ahmad and Bird (1998), such transfers may induce low `tax effort' in the regions. The purpose of this paper is to investigate theoretically and empirically this relationship between intergovernmental transfers and local tax effort. An initial problem to deal with is the definition of `tax effort' in itself. First, one can associate tax effort to high tax rates. Smart (1998) asserted that such association is inadequate. Second, one can measure tax effort using actual tax revenues or the difference between actual the predicted value of tax revenues. This approach has been mainly adopted by the empirical literature on the relationship between intergovernmental transfers and local tax effort [Baretti, Huber and Lichtblau (2000), Von Hagen and Hepp (2000), Jha, Mohanty, Chattergee and Chitkara (1999), Sagbas (2001)]. Although tax revenue is an accurate and observable variable, still one can hardly say that it is a good estimate of tax effort. The reason is for a given region in a given time period tax revenue is affected by many potential variables outside the control of local governments (like idiosyncratic shocks to some specific tax bases) which are seldom well controlled for in estimates of tax capacity. In practice local tax effort encompasses a broad set of actions. One of them is clearly the battle against tax evasion. In spite of its importance, this problem has been only recently addressed by the local public finance literature. Bordignon, Manasse and Tabellini (1996), presented a model where a local government exerts costless effort to catch tax evader workers and they showed how intergovernmental transfers affect tax enforcement. The drawback of this model is that, in reality, tax enforcement is not costless and the cost depends upon other variables chosen by local authorities, like the efficiency of the local tax administration. Although Prud'homme (1995) and Tanzi (1996) have informally signaled the possible inefficiencies of the local tax administrations, this feature has not been raised by the theoretical or the empirical literature. The purpose of this paper is precisely to incorporate such dimension in the assessment of the relationship between intergovernmental transfers and local tax effort. The theoretical framework assumes that in each region there is one representative habitant and a local government. The habitant posses a low or a high-valued property. The local government maximizes tax revenues. In a first period, the local government invests resources to improve the efficiency of the tax administration or to lobby the central government in order to obtain discretionary transfers. This decision is affected by the political cost of reforming the tax administration and on the ability of the local government to negotiate with the central government. Thus, in our model, intergovernmental transfers are endogenous and simultaneously determined with the reform of the local tax system. In a second period, the local government sets the property tax schedule. But, as the local government is unable to observe the value of the property, it has to rely on the habitant announcing this value. Finally, in the third period, the local government decides to enforce the tax law by randomly auditing such announcement. If the habitant is discovered having misreported, the local government sets the corresponding property tax and imposes a penalty. We assume that audit is perfect but costly; the cost depending on the efficiency of the local tax administration. We solve the model backwards. As the local government cannot commit to the auditing probability when it designs its tax policy, the equilibrium of the audit-report game is in mixed strategies, with auditing and tax evasion. Then we find the optimal tax schedule. In order to reduce the stake for tax evasion, the local government distorts downwardly the high-valued property tax. Finally, we solve for the decision of the local government regarding how much resources to invest for improving the efficiency of the tax administration. We find that this decision is negatively associated with the domestic political costs and positively with the ability to negotiate with the Federal Government. The predictions of the model are empirically tested using data for Argentina. The theory suggests a two-step approach. In a first stage we run a probit estimation where the probability of a certain province to reform its tax system (or receiving discretionary transfers) in a given year will be correlated with domestic political variables (e.g. divided government) and also with variables describing its bargaining power vis a vis the federal authorities (e.g. political representation at the National Congress, political party of the President vis a vis that of the Governor). In a second stage, we include this exogenous instrument of tax reform in a regression where the evolution of actual provincial tax receipts are regressed against this variable plus other controls like population, density, provincial income distribution and production structure. Notice that this two stage empirical approach allow us to deal with a frequent problem encountered in the empirical literature given by the endogeneity bias affecting some of the variables of interest, like federal transfers (e.g. Jha, Mohanty, Chattergee and Chitkara (1999), Sagbas (2001)).

Suggested Citation

  • Pablo Sanguinetti & Martin Besfamille, 2004. "Exerting local tax effort or lobbying for central transfers?: Evidence from Argentina," Econometric Society 2004 Latin American Meetings 249, Econometric Society.
  • Handle: RePEc:ecm:latm04:249
    as

    Download full text from publisher

    File URL: http://repec.org/esLATM04/up.16682.1082059515.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. von Hagen, Jürgen & Hepp, Ralf, 2000. "Regional risksharing and redistribution in the German federation," ZEI Working Papers B 15-2000, University of Bonn, ZEI - Center for European Integration Studies.
    2. Mariano Tommasi & Sebastian Saiegh & Pablo Sanguinetti, 2001. "Fiscal Federalism in Argentina: Policies, Politics, and Institutional Reform," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 157-212, January.
    3. Graetz, Michael J & Reinganum, Jennifer F & Wilde, Louis L, 1986. "The Tax Compliance Game: Toward an Interactive Theory of Law Enforcement," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 2(1), pages 1-32, Spring.
    4. Mariano Tommasi & Mark P. Jones & Pablo Sanguinetti, 1997. "Politics, Institutions, and Fiscal Performance in the Argentine Provinces," Working Papers 16, Universidad de San Andres, Departamento de Economia, revised Apr 2000.
    5. Bernd Huber & Christian Baretti & Karl Lichtblau, 2000. "A Tax on Tax Revenue. The Incentive Effects of Equalizing Transfers: Evidence from Germany," CESifo Working Paper Series 333, CESifo.
    6. Prud'homme, Remy, 1995. "The Dangers of Decentralization," The World Bank Research Observer, World Bank, vol. 10(2), pages 201-220, August.
    7. Massimo Bordignon & Paolo Manasse & Guido Tabellini, 2001. "Optimal Regional Redistribution under Asymmetric Information," American Economic Review, American Economic Association, vol. 91(3), pages 709-723, June.
    8. Michael Smart, 1998. "Taxation and Deadweight Loss in a System of Intergovernmental Transfers," Canadian Journal of Economics, Canadian Economics Association, vol. 31(1), pages 189-206, February.
    9. Jones, Mark P. & Sanguinetti, Pablo & Tommasi, Mariano, 2000. "Politics, institutions, and fiscal performance in a federal system: an analysis of the Argentine provinces," Journal of Development Economics, Elsevier, vol. 61(2), pages 305-333, April.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Prasant Kumar Panda & Velan Nirmala, 2013. "Central Fiscal Transfers and States' Spending In India: An Analysis of Incentive Effect," Economics Bulletin, AccessEcon, vol. 33(2), pages 1229-1246.
    2. Abdul Jalil, Ahmad Zafarullah & Abdul Karim, Noor Al-Huda, 2009. "Understanding Malaysian State Governments Fiscal Behavior: The Role of Intergovernmental Transfers," MPRA Paper 25188, University Library of Munich, Germany.
    3. Abdul Jalil, Ahmad Zafarullah, 2009. "Decentralization, Subnational Governments' Behaviour and Macroeconomic Instability: The Case of Malaysia," MPRA Paper 19071, University Library of Munich, Germany.
    4. repec:gig:joupla:v:6:y:2014:i:1:p:3-44 is not listed on IDEAS
    5. Yongzheng Liu & Jianmei Zhao, 2011. "Intergovernmental fiscal transfers and local tax efforts: evidence from provinces in China," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 14(4), pages 295-300, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Sanguinetti, Pablo & Tommasi, Mariano, 2004. "Intergovernmental transfers and fiscal behavior insurance versus aggregate discipline," Journal of International Economics, Elsevier, vol. 62(1), pages 149-170, January.
    2. Bird, Richard M. & Smart, Michael, 2002. "Intergovernmental Fiscal Transfers: International Lessons for Developing Countries," World Development, Elsevier, vol. 30(6), pages 899-912, June.
    3. Hindriks, Jean & Peralta, Susana & Weber, Shlomo, 2008. "Competing in taxes and investment under fiscal equalization," Journal of Public Economics, Elsevier, vol. 92(12), pages 2392-2402, December.
    4. Chari, V.V. & Kehoe, Patrick J., 2007. "On the need for fiscal constraints in a monetary union," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2399-2408, November.
    5. HINDRIKS, Jean & PERALTA, Susana & WEBER, Shlomo, 2005. "Fiscal competition, revenue sharing, and policy-induced agglomeration," LIDAM Discussion Papers CORE 2005093, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. José Bercoff & Osvaldo Meloni, 2009. "Federal budget allocation in an emergent democracy: evidence from Argentina," Economics of Governance, Springer, vol. 10(1), pages 65-83, January.
    7. Roberto Cortes Conde, 2008. "Spanish America Colonial Patterns: The Rio de La Plata," Working Papers 96, Universidad de San Andres, Departamento de Economia, revised Mar 2008.
    8. Ulrich Thießen, 2004. "Fiscal Federalism in Transition: Evidence from Ukraine," Economic Change and Restructuring, Springer, vol. 37(1), pages 1-23, March.
    9. Varadarajan V. Chari & Patrick J. Kehoe, 2008. "Time Inconsistency and Free‐Riding in a Monetary Union," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1329-1356, October.
    10. Boriss Siliverstovs & Ulrich Thiessen & Caroline Elliott, 2015. "Incentive effects of fiscal federalism: Evidence for France," Cogent Economics & Finance, Taylor & Francis Journals, vol. 3(1), pages 1017949-101, December.
    11. Meloni, Osvaldo, 2011. "Budget Manipulation and Vertical Fiscal Imbalance," MPRA Paper 50694, University Library of Munich, Germany.
    12. Erkan Erdogdu, 2014. "The Political Economy of Electricity Market Liberalization: A Cross-country Approach," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
    13. Robin Boadway & Jean-Francois Tremblay, 2005. "A Theory of Vertical Fiscal Imbalance," Working Papers 2006-04, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
    14. Felix Rösel, 2017. "The Political Economy of Fiscal Supervision and Budget Deficits: Evidence from Germany," Fiscal Studies, Institute for Fiscal Studies, vol. 38, pages 641-666, December.
    15. Rosella Levaggi & Francesco Menoncin, 2014. "Health care expenditure decisions in the presence of devolution and equalisation grants," International Journal of Health Economics and Management, Springer, vol. 14(4), pages 355-368, December.
    16. Jeferson Luis Bittencourt & Ronald Otto Hillbrecht, 2003. "Ciclo Político na Economia Brasileira: um Teste para a Execução Orçamentária dos Governos Estaduais - 1983/2000," Anais do XXXI Encontro Nacional de Economia [Proceedings of the 31st Brazilian Economics Meeting] b32, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    17. Meloni, Osvaldo, 2014. "Does poverty relief spending reduce crime? Evidence from Argentina," International Review of Law and Economics, Elsevier, vol. 39(C), pages 28-38.
    18. Enikolopov, Ruben & Zhuravskaya, Ekaterina, 2007. "Decentralization and political institutions," Journal of Public Economics, Elsevier, vol. 91(11-12), pages 2261-2290, December.
    19. Shah, Anwar, 2005. "Fiscal decentralization and fiscal performance," Policy Research Working Paper Series 3786, The World Bank.
    20. Li, Wei & Qiang, Christine Zhen-Wei & Xu, Lixin Colin, 2005. "Regulatory Reforms in the Telecommunications Sector in Developing Countries: The Role of Democracy and Private Interests," World Development, Elsevier, vol. 33(8), pages 1307-1324, August.

    More about this item

    Keywords

    local tax effort - discretionary transfers - tax enforcement;

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecm:latm04:249. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christopher F. Baum (email available below). General contact details of provider: https://edirc.repec.org/data/essssea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.